1999 Federal Budget

46(1)

On February 16, 1999 the Minister of Finance presented his sixth budget to the House of Commons. The Minister reported a balacnced budget for 1998-99 and a similar commitment for the next two years. Some tax proposals include:

Income Tax

1. Personal Exemption

increases the 1998 additional $500 personal exemption to $675 and extends this to all taxpayers over 2 years.

2. Surtax

Eliminates the 3% surtax for all taxpayers over 2 years.

3. Income Splitting with minor children

This proposal constitues a special tax at the top marginal tax rate on certain income of individuals age 17 or under including:

• taxable dividends and other share holder benefits on unlisted shares of Canadian and foreign companies (received directly or through a trust or partnership); and
• income from a partnership or trust where the income is from providing goods or services to a business carried on by a relative of the child or in which the relative participates.

These rules do not apply to capital gains or employment income. This applies to the 2000 and sub-sequent taxation years with no grandfathering for trust’s established before the Budget.

4. Retroactive Lump-Sum Payments

Proposes that individuals receiving qualifying retroactive lump sum payments of $3,000 or more after 1994 be allowed a special tax calculation. Eligible income includes:

1. Income from employment or, because of the termination of employment;
2. Pension benefits, other than non-periodic benefits;
3. Spousal or child support amounts;
4. Employment insurance and other prescribed benefits.

Written requests for the special calculation should be sent to Revenue Canada.

5. Civil penalties for misrepresentations of tax matters by third parties

Canadian tax law includes criminal and civil penalties for misrepresentations of tax matters. The Budget proposes to also apply civil penalties to third parties that make false statements or omissions in relation to tax matters.

Tax shelter and other tax planning arrangements

Applies to a person who plans, promotes or sells an arrangement that the person knows or would have known, but for circumstances amounting to gross negligence, includes a false statement or omission that may be used for tax purposes. The penalty will be the greater of $1,000 and 100 per cent of the gross revenue.

Advising or participating in a false filing

This applies to a person who participates in the making of a false statement or omission. The penalty will be the greater of $1,000 and 50 percent of the tax sought to be avoided or refunded. Example:

Accountant X receives a box of receipts from Client Y and agrees to prepare a business expense statement for Y. Accountant X includes say $5,000 cost of Y’s family vacation, which X knew to be a non-deductible personal expense, as a business expense in Y’s tax return. Accountant X is liable because he or she knew of the false statement and may also be subject to criminal prosecution.

6. Medical expense tax credit (METC)

The Budget proposes to extend the METC to remuneration for the care and supervision, therapy and tutoring for persons with certain disabilities.

Charities

46(7)

Donation Options

Some options other than the common method of cash donation include:

1. Life insurance donation

Acquire a life insurance policy and name the charity as the beneficiary. Premium payments made by the donor on behalf of the charity would be considered donations. Another option is to name the Estate as a beneficiary of the policy and make a specific request in the Will to the charity. This would be considered a gift made by the donor in the year of death and eligible up to 100% of net income for the year and, the immediately preceding year. Even though the insurance proceeds would be subject to probate, the donation could offset tax liabilities which arise in the year of death.

2. Residual Interest in Property

If a donor wishes to use a property for the remainder of his/her lifetime, the residual interest could be gifted to the charity. The donation will be for the value of the residual interest.

3. Charitable Remainder Trusts

A trust is established by an irrevocable transfer of property, such as cash, to a trustee. The charity is the residual beneficiary but the donor retains the right to income during his/her lifetime. The gift is calculated by discounting the current value of the property using the life expectancy of the donor and a current interest factor.

Charitable Foundations

Some points to consider include:

1. Once a person has current and future resources provided for, they often look to charitable giving, perhaps through a private or public charitable foundation.
2. The donor may make an irrevocable gift to the foundation for an income tax receipt and the foundation would invest the funds on a tax-free basis to make payments to registered charities.
3. The investments, charitable recipients, and compliance are the responsibility of the foundation’s board of directors or trustees.
4. The foundation has strict rules regarding the use of the money, disbursement quotas, and non-qualifying investments.
5. The foundation must be registered with Revenue Canada and operated exclusively for charitable purposes such as, relief of poverty, advancement of education, advancement of religion and other purposes beneficial to the community.
6. No part of the funds may be made available to a member of the foundation and, the foundation is not permitted to carry on a business.
7. In a private foundation, more than 50% of the directors of the foundation do not deal at arm’s length with each other or, more than 50% of the capital contributed to the foundation comes from a single source.
8. A public foundation may be established by a number of arm’s length people or, contributions may be simply made to an arm’s length community foundation.
9. An advantage is that if the family wishes to contribute, say, $50,000 for charitable giving over a number of years, the amount may be given to the foundation and earn tax-free interest pending the actual distribution to the charities.
10. An advantage of a public foundation is that publicly traded securities may be donated to the foundation with a reduced capital gains inclusion rate from 6/8’s to 3/8‘s.

Art Flips

In a Tax Court of Canada case, the taxpayer paid $5,000 for four paintings which were donated to a charitable organization for receipts of $15,000 even though the taxpayer had never seen the paintings, was not familiar with the charity and was not the one who chose the charitable organization - the entire transaction was handled by an associate. The Court found that the taxpayer did not acquire ownership of the pictures and therefore, he could not make a gift - even though the charity in fact sold the paintings on auction for $2,455. Also, the taxpayer was subject to 50% gross negligence penalties because he knowingly made a false statement in his returns.

Child Care Expenses

46(11)

In a Tax Court case, Mrs. B worked full-time from 9:00 A.M. to 5:00 P.M. five days a week and, also part-time for two other companies. She paid Mrs. R $720 per week to babysit her three children. The Court disallowed the child care expenses because Mrs. B did not provide enough evidence to support the deductions. If requested from Revenue Canada, there is a requirement to prove the expenditures.

Demutualization

46(2)

The Department of Finance has introduced legislation that will allow large, federally regulated, mutual life insurance companies to demutualize by converting to stock companies.The following companies intend to develop demutualization plans:

1. The Mutual Life Assurance Company of Canada;
2. The Manufacturer's Life Insurance Company
3. Sun Life Assurance Company of Canada
4. The Canada Life Assurance Company.

When a company demutualizes, its total value is allocated to eligible policy holders in exchange for their ownership rights. The policy holders may choose to receive shares or dividends. If all conversions are approved it is estimated that two million policy holders will receive benefits valued at $10 billion.

Questions and Answers

Q. How will I be taxed on my demutualization benefits?

A. If you receive a share, there is no immediate tax consequence. The adjusted cost base of the share is zero. However, when you dispose of the share, you may have a capital gain. If you receive a benefit other than a share (e.g. cash), it will be taxed as a dividend and the insurance company will issue a T5 slip.

Q. Who are eligible policy holders?

A. Policy holders on the day that the company announced its intention to demutualize and persons whose policy had lapsed before the eligibility date but were reinstated before the special meeting called to vote on demutualization. You may contact your insurance company to determine whether or not you qualify.

Q. Should a policy holder choose cash or shares?

A. If a policy holder is content to hold shares it may be best to take shares as there is no tax on the receipt of shares whereas, there is a tax liability on the receipt of cash.

However, if the policy holder does not intend to hold the shares, a sale would trigger a capital gain which is taxed at a slightly higher rate than dividends. Therefore, in this case, it may be best to simply take the cash.

Q. Does this affect income or means-tested government programs such as the child tax benefit and the guaranteed income supplement?

A. To the extent that the benefit is taken as a dividend, the recipient’s income will be increased.

Q. How does this affect a Canadian-controlled private corporation who owns a life insurance policy on its shareholders or employees?

A. Dividends received will be subject to a refundable 33 1/3% tax under Part IV of the Income Tax Act. Shares will not trigger tax until they are sold. Normal capital gain treatment will result.

Old Age Security Clawback

40(4)

Individuals with income in 1998 over $53,215 will find that their old age security will be subject to withholdings effective July 1999. However, if the 1999 income is going to be significantly lower than 1998, it may be possible to obtain a waiver of the withholdings by applying to Revenue Canada.

United States Taxation

46(6)

Some frequently asked questions include:

Q. I recently won some money in Las Vegas and the Casino withheld 30%. How can I get this money back?

Answer: You are allowed to file a U.S. income tax return on which you are allowed to offset your gambling losses in the year against gambling winnings in that same year. To prove your gambling losses, you may be required to provide various documentation which could include a diary of winnings and losses, wagering tickets, cancelled cheques, casino credit records, casino cheque cashing records and statements provided by the casino.

Q. I own a U.S. rental property but I always have a loss. Do I need to file a U.S. income tax return?

Answer: U.S. rental income is considered passive income and is subject to a U.S. withholding tax of 30% on the gross rental revenue. However, the taxpayer may elect to file on a net basis but must file Form 1040NR.

Q. I am a resident of Canada but I worked temporarily in the United States for which I received a Form W2. Do I need to file a U.S. income tax return or can I just claim the U.S. taxes withheld as a foreign tax credit in Canada?

Answer: Canada will not accept U.S. federal and state income taxes withheld on a W2 as proof of foreign taxes paid. To establish your actual U.S. income tax liability, you must file a U.S. tax return on Form 1040NR. If you had state income taxes withheld, you would also have to file a state return to establish the tax liability with respect to that state. You may also claim as a foreign tax credit social security and medicare premiums that have been deducted on the W2 form.

Q. I am a U.S. citizen who has taken up residence in Canada. All my income is from Canada. Do I have to file a U.S. income tax return? How many years do I have to file, if I never filed before?

Answer: U.S. tax rules require U.S. citizens to file U.S. personal income tax returns on Form 1040 based on their worldwide income regardless of where they reside. To avoid a double tax burden, U.S. citizens who reside abroad are allowed to claim a foreign earned income exclusion and are also allowed to claim a foreign tax credit to the extent it is required.

Caution:

U.S. Taxation is extremely complicated. Specialized professional assistance may be needed.

Federal Youth Hires Program

46(9)

This program provides relief for employers that have an increase in their Employment Insurance (EI) premiums for employees from the ages of 18 to 24 in 1999 and 2000. The relief will depend on the increase compared to the 1998 base year. As long as an individual is 18 to 24 years of age sometime in 1998, 1999 or 2000, the earnings are included in the program for that year’s calculations. Employers will have the option of adjusting their premium payments during the year, or claiming relief after the end of the calendar year when they file their T4 Returns. New employers who start business in 1999 or 2000 are also eligible for the program. This is available even if new employees are not hired in 1999 as long as the 1999 insurable earnings for this group exceed that for l998. There is no effect on employee EI premium’s.

Farming

46(10)

Retiring Allowance

Revenue Canada noted that where a farm proprietor wishes to either sell or rent the farm, he may pay a tax deductible retiring allowance to a spouse who was an employee of the farm, within limits, the retiring allowance may be rolled over to an RRSP.

Research & Development

Some examples of successful farm Research & Development claims include:

1. A "seed grower" recovered about $40,000 per year since 1994 on Agronomic research. The Company had test plots for various trials of seed varieties, chemicals, etc.
2. A family farm corporation operated a hog farm finishing operation and recovered $10,000 on the development of a new device.
3. A forage processing company conducted a qualifying experiment to determine if circulation of natural air in a storage shed could assist to dry baled forage. An engineering consultant conducted the experiment.
4. A greenhouse company recovered a significant portion of the capital cost incurred on a new greenhouse to develop a growing protocol to control the bacterial growth that caused root rot.

Farm Corporation Split Up

Revenue Canada provided a Ruling on a tax-free split-up of a farm corporation owned by three brothers. The Ruling deals with land and buildings, machinery and equipment, livestock, feed, grains, cash, accounts receivable, patronage reserves, net income stabilization accounts, principal residences located on different quarter sections of land, shareholder loan credits and an operating line of credit.

Cat/Dog Food Deductible

In a Technical Interpretation, Revenue Canada note that the cost of food for ‘barn cats" used to control mice in barns and food for guard dogs used to protect farm property and other farm animals are deductible expenses as they are incurred to produce income from the farm business.

In This Issue...

• 1999 Federal Budget
• Demutualization
• Registered Retirement Savings Plan (RRSP)
• Old Age Security Clawback
• Employees
• United States taxation
• Charities
• Contract Payment Reporting System
• Federal Youth Hires Program
• Farming
• Child Care Expenses

Past Issues - more tips

Registered Retirement Savings Plan (RRSP)

46(3)

RRSP investments in Mortgages

A mortgage may be held as a qualified investment in an RRSP where the mortgage is in respect of real property situated in Canada and insured under the National Housing Act, or by a corporation offering its services to the public in Canada as an insurer of mortgages, and administered by an approved lender under the National Housing Act. This means that even non-arm’s length mortgages may be qualified investments IF they meet all these criteria.

Arm’s Length Mortgage Investments

Revenue Canada reviewed a situation where a Company was incorporated to develop a real estate project and a number of unrelated Canadian individuals owned the shares. The Company acquired a property financed by a first mortgage and was proposing to obtain additional financing by having each of the shareholders other than "xxx" to have their self-directed RRSP’s invest in a second mortgage secured by the Project. The second mortgages would be administered by a financial institution, would bear interest at a reasonable rate and would mature on a normal date. One of the shareholders did not invest because there were no funds available in his RRSP.

Good News!

Provided that the annuitants of the RRSP’s that invest in the second mortgages deal at arm’s length with the company, the second mortgages will be qualified investments for an RRSP.

Caution: Because of the tax complexities of RRSP mortgage investments, a Tax Ruling should be considered.

Lifelong Learning Plan

The 1998 Federal Budget proposes to allow individuals to borrow funds tax free from their RRSPs to finance their education, and the education of their spouse. The loan may be up to $10,000 in a year to a maximum of $20,000 over four years. It must be repaid over ten years commencing within five years of borrowing the money or, after the education period ceases.

Employees

46(5)

Gifts

Gifts to employees are generally taxable benefits unless the gift is for a wedding, Christmas, or similar occasions and is valued at $100 or less and, the employer does not deduct the gift as an expense. The practice generally allows one gift per employee per year unless one of the gifts is a wedding gift. Revenue Canada does not have an exhaustive list of "similar occasions" but the term would likely include birthdays, the birth of a child, project milestones, graduations, and retirements. Also, Revenue Canada notes that where the award is a plaque, trophy or other memento of nominal value, it is not necessary to include any amount in income.

Parking Benefits

Revenue Canada notes that an employee parking benefit may not be taxable where:

1. A business operates at a shopping centre or industrial park and parking is also available to non-employees; or
2. An employer provides on a first-come, first-served basis scramble parking. (i.e. there are fewer spaces than there are employees who require parking)

There also may not be a taxable benefit when parking is provided to employees for business purposes and, employees regularly have to use the automobile to perform their duties.

Mental Distress Damages

In a recent Court case, the Court determined that the portion of a wrongful dismissal settlement which was for damages for mental distress was not taxable.

Director Liability

In a Tax court case, Director Mr. M was found personally liable for unremitted GST. The Court noted that all of the directors are jointly and severally liable whether they are classified as inside, outside, titular, nominal directors or otherwise and, immaterial of their participation in the operations of the corporation unless, the due diligence exception is met.

Contract Payment Reporting System

46(8)

Some points mentioned in Revenue Canada’s Website at http://www.rc.gc.ca/contract/ include:

1. This reporting applies to every person or partnership, whose business income is derived primarily (a 50% test) from construction activities, that pays or credits after 1998 an amount over $500 to a subcontractor for goods or services provided in the course of construction including, but not limited to, erection, excavation, installation, alteration, modification, repair, improvement, demolition, destruction, dismantling or removal of all or any part of a building, structure, surface or sub-surface construction, or any similar property. The first returns are to be filed by March 31, 2000.
2. Construction could include work such as acoustical, air conditioning, asphalt paving, carpet, commercial refrigeration, concrete pouring and finishing, demolition, dry and wet heating, dry-walling, duct and sheet metal work, electrical, elevator and escalator, environmental control, excavating and grading, fencing, finished carpentry, forms, gas pipes, glass and glazing, hardwood flooring installation, heavy equipment rental with an operator, insulation, masonry, painting and decorating, pile driving, plastering and stucco, plumbing, pre-cast concrete installation, resilient flooring and carpets, roofing and shingling, rough and framing carpentry, septic system installation, sheet metal and built-up roofing, shingling, siding, sprinkler system, steel reinforcing, structural steel erection, swimming pool installation, terrazzo and tile, water well drilling, wrecking and demolition. Examples of surface or sub-surface construction include highways, streets and bridges, water works and sewage, hydroelectric power plants, power and telecommunication lines, gas and oil pipelines, industrial and commercial buildings, personal homes and residences, and apartment buildings.
3. Persons that are not primarily in the business of construction do not have to report. This includes homeowners, governments, non-profit organizations, and businesses not primarily in construction.
4. Businesses may report payments on either a calendar or fiscal year basis. For example, a business with a January 31,1999 year-end that chooses to file on a fiscal basis would report the transactions for the one month in 1999 by the due date of March 31, 2000.
5. Contractors must make a reasonable effort to obtain the required information from the subcontractor, such as the Business Number, to avoid penalty. If reasonable efforts are made but the subcontractor refuses to provide the information, the subcontractor will be subject to a penalty. Therefore, it is important for the general contractor to retain proof that the information was requested.
6. Contractors will not be required to provide a copy of the information slip to the subcontractor although, Revenue Canada encourages the contractors to do so.
7. Goods only payments dot not have to be reported however, mixed service and goods payments have to be reported if there is a service component of $500 or more.
8. The accuracy of what is reported under the Contract Payment Reporting System will be reviewed in the usual course of Revenue Canada audits.
9. Revenue Canada will not reimburse the contractor for the extra costs to file this information.